Chapter Ill Investigation
| Jurisdiction | United States |
Chapter Ill Investigation
A. Basic Areas of Investigation
Section 1103(c)(2) of the Bankruptcy Code sets forth one of the basic powers of a chapter 11 creditors' committee: to "investigate the acts, conduct, assets, liabilities, and financial condition of the debtor, the operation of the debtor's business and the desirability of the continuance of such business, and any other matter relevant to the case or to the formulation of a plan." "Other matters," as referred to in § 1103(c)(a) of the Bankruptcy Code, may include, for example, the investigation of (1) the debtor's and its management's pre-petition actions and transactions and the propriety thereof, (2) whether and to whom preferential and fraudulent transfers were made, (3) whether asserted claims (in particular, secured and priority claims) against a bankruptcy estate are valid, and (4) other potential causes of action and claims of a bankruptcy estate. While the committee's investigative authority is generally broad, the extent and types of investigation by a committee in a particular case will depend on various factors, including the size and nature of each chapter 11 case.77 In some cases, the committee's investigations must be conducted expeditiously where, for example, the debtor's assets may deteriorate in value (for example, business assets may deteriorate in value in an unnecessarily prolonged bankruptcy sale process).
Importantly, a fundamental purpose of a committee is to maximize the recovery of general unsecured creditors — whose interests the committee represents — and thus, the committee's investigations should normally be undertaken with that purpose in mind, as well as the basic committee function of monitoring the debtor's affairs.78
Relatedly, a committee's investigations should typically be geared toward obtaining the information necessary for a committee to (1) determine whether reorganization, liquidation and/or a combination thereof (or even perhaps conversion of a case to a chapter 7 proceeding or a dismissal of a case) is the best strategy and alternative in a debtor's case, and (2) negotiate with a debtor and its key players on an informed basis regarding the terms of a plan of reorganization or liquidation or otherwise formulate and/or support another plan in the case. A committee's role in the plan process is often cited as the committee's most important role in a chapter 11 case.79
At the outset of a case, a basic area of investigation by the committee will typically be the debtor's operations, assets and liabilities, source of financial distress, liquidity and financial viability. A committee will need to understand the foregoing in order to determine the optimal strategy in a debtor's case (e.g., reorganization, liquidation, fundamental business changes, etc.), as well as to ensure that a bankruptcy estate's assets are being properly preserved during the case and that current management is capable of properly continuing operations and administering a case.80 Often included as part of such investigations would be the gathering and analysis of information to perform a liquidation analysis to establish a worst-case scenario, which will assist the committee in understanding, among other things, the potential recovery for unsecured creditors.
Relatedly, to maximize creditor recoveries, a committee must understand the bankruptcy estate's assets, including potential causes of action and claims against third parties, such as voidable preferential and fraudulent transfers, and the costs, benefits and risks of prosecution. A committee may assist the debtor (or in some cases take the lead if the debtor is reluctant) on prosecuting certain valuable bankruptcy estate claims and marshalling unencumbered and other assets for distribution to unsecured creditors.81
As part of its investigations, a committee should also understand the debtor's liabilities, especially secured and priority claims, which are senior in priority to general unsecured claims. Having an accurate picture of the debtor's valid liabilities will again assist with a committee's determination of the best case and exit strategies. Further, a committee may want to object to and challenge invalid claims and the purported liens and security interests of a debtor's pre-petition secured creditors in order to maximize the recovery to unsecured creditors.82
As one court recognized, one of the functions of a committee is to "investigate the legitimacy of creditors' claims" and to determine whether there are any actions that should be pursued by the bankruptcy estate against any creditor.83 Such information will also enable a committee to evaluate its potential litigation position and negotiating room with secured and priority creditors. Additionally, in some cases, a debtor may be hesitant to pursue avoidance actions against trade creditors and vendors in order to preserve goodwill between the parties post-confirmation (if the debtor is reorganized). In such cases, a committee, a temporary body charged with ensuring ratable, maximized recoveries for unsecured creditors, may be a more ideal party to analyze and pursue such avoidance actions.
Depending on the dynamics of the case, another focus of the committee's investigations may be the pre-petition conduct of, and transactions with, the debtor's management (e.g., whether management breached its fiduciary duties, mismanaged operations, or took other improper actions or failed to take proper actions in light of the debtor's financial condition). In appropriate instances, committees have been authorized to commence lawsuits on behalf of the bankruptcy estate.84 Investigation of management's pre-petition actions and/or omissions may also assist with a committee's assessment of current management's ability to reorganize a debtor or otherwise properly administer a debtor's case and whether the appointment of a trustee (to supplant the debtor in possession) may be in the best interest of creditors.
B. Tools for Investigation
There are various mechanisms and/or tools available to a committee to conduct investigations.
1. Information from the Debtor
Under § 1103(c)(1) of the Bankruptcy Code, while a committee may not assume any management responsibility or be involved in managing the debtor's day-to-day business, a committee may consult with a debtor (or trustee) concerning the administration of a case, and a debtor in possession has a duty under § 1103(d) of the Bankruptcy Code to meet with the committee after its appointment to discuss appropriate case matters. The consultation role can be performed, for instance, through periodic meetings or other regular communications with a debtor and/or its professionals and advisors. Often, key executives/employees of a debtor and its bankruptcy counsel, the committee chairperson and committee counsel may attend such meetings.
In some cases, a...
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